The public is misinformed about most aspects of financial planning and investments, and as the fields keep expanding, the gulf most consumers need to cross to understand them grows even faster.
The subject matter is complicated. It doesn’t help that financial planning and investments are areas in which most people do a terrible job of judging their own competency, and in which most people have little or no training. We don’t learn finance in grade school or high school, and most people don’t take it in college. We typically learn about it from our families and the media, neither of which necessarily have any particular expertise.
I have met some people who have underestimated their financial knowledge and abilities and many, many more who have overestimated them. As bad as the public’s knowledge of financial planning is, its misperceptions and faulty information about investments is probably worse.
A little while back I received a call from someone who was inquiring about our services. Early in the conversation he told me that I would consider him a knowledgeable investor because most of his peers did. (He did not say who his peers were, or on what basis they could judge him.) Then he asked me, “so what do you guys do: hedge, options, futures, shorts?” When I replied “ordinarily no” to all four, he told me we were constraining ourselves by not pursuing those strategies.
He then said that “European government bonds are yielding two percent more than the equivalent U.S. Treasuries, and the dollar is definitely going to continue to go down against the Euro, so why aren’t you just buying those European bonds?” (We do buy both U.S. and European bonds through funds that hedge for currency risk.)
I asked him two relatively simple questions about the risks involved in his idea concerning the relationships between interest rates and currencies, and the relationship between bonds yields and their prices, neither of which he could answer. These were important questions because small changes might decrease the value of his investment to a greater extent than the return he expected to receive by reaching for the extra yield. For a paltry amount of extra return, he was ready to take on a lot of risk, and he didn’t even know it. He hung up in a huff.
I have conversations on a regular basis with people who have no knowledge or experience with finance or investments who pursue all kinds of risky strategies: divorce lawyers trading options; doctors shorting stocks; and plumbers that day trade. They compound their problems greatly by not even knowing that what they are doing is risky!
While investments have always been difficult for consumers to figure out, the ideas behind financial planning are still relatively new, and as the field grows it seems to get harder. There has been a surge in the available financial products, and much of the decision-making framework keeps changing.
I think most people would be well served by working with a competent, independent financial planner.